The Securities and Exchange Commission was incompetent in pursuing Bernie Madoff's Ponzi scheme, but not due to any inappropriate connections between the two parties, the agency's watchdog said Wednesday.

The investigation by David Kotz, the SEC's inspector general, did not find any evidence that agency employees "had any financial or other inappropriate connection" with Madoff or his family that influenced their examination of his business. Even former SEC assistant director Eric Swanson's relationship with Madoff's niece Shana did not influence the agency's probe, Kotz found, according to an executive summary released today.

However, the watchdog did determine that the agency received "more than ample information in the form of detailed and substantive complaints over the years to warrant a thorough and comprehensive examination and/or investigation" of Madoff. Over the course of 16 years, from 1992 to Madoff's confession in 2008, the agency received six – arguably even eight – "substantive complaints that raised significant red flags" about Madoff's business.

But, Kotz concluded, "Despite three examinations and two investigations being conducted, a thorough and competent investigation or examination was never performed."

Part of the problem, Kotz found, was that the SEC staffers handling the issue were "relatively inexperienced", causing them to accept Madoff's "seemingly implausible" explanations, fail to follow up on inconsistencies, and decline whistleblower's offers for additional evidence. Also, two SEC examinations of Madoff were taking place at the same time in different agency offices – and neither office knew about the other's efforts.

The complete 450-page report on Kotz's investigation is expected to be released on Friday, SEC chairman Mary Schapiro said in a letter to Sen. Chuck Grassley, R-IA. Grassley asked Kotz in December to look into how Madoff's fraud continued for so long after the SEC started investigating the schemer.

In a statement today, Grassley said, "The SEC's failure to follow up aggressively on detailed and specific information about Madoff's fraud is further evidence of a culture of deference toward the Wall Street elite at the SEC. Until that culture is transformed, the SEC will not be the tough cop on the beat that the public needs."

Senate Banking Committee Chairman Chris Dodd

In her letter to Grassley, Schapiro noted that the agency "already has taken a number of steps since the Madoff fraud was revealed late last year to better protect investor assets and improve our surveillance."

Senate Banking Committee Chairman Chris Dodd said his panel will hold a hearing next Thursday September 10 on Kotz's report. The Connecticut lawmaker, citing a "string of massive regulatory failures and incompetent investigations" at the agency, used the report's release to reiterate the need for financial regulatory reforms currently making their way through Congress.

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